Ben Bernanke’s reappointment as Chairman of the Federal Reserve Board, once regarded as a sure thing, is now being questioned. Paul Krugman, who has personal reasons for feeling loyal to Bernanke, nevertheless neatly summarises the reasons for being against him. As Calculated Risk argues, Bernanke supported some of the bubble-ignoring policies that led to the crisis – he even authored with Mark Gertler some of the papers people use to argue for the futility of using asset prices in the central banker’s monetary reaction function.
On the other hand, Time has just made him Person of the Year for his reaction to the financial crisis and ensuing recession. His writings on the Great Depression formalised an role for the credit mechanism – ie banks failing – in the propagation of economic shocks – a doctrine that still dismays Tim Congdon, but that the rest of us regard as incredibly important in the light of the *$**!*!%* that the banks have made of the economy this last two years. Having such a man in charge during the dark days of autumn 2008 may have made a critical difference.
However, that is the past. I want to focus on another aspect of his job, the one to do with guaranteeing a strong recovery from this slump. Despite US rates being lower than EU rates for the last 2 years, Bernanke is coming under pressure for worrying more about inflation than unemployment. As I explain below, such worrying is a critically important ‘act’ of Bernanke’s. As a result, no less a writer than the Economist’s economics blogger has been asking about ‘his refusal to do his job’:
There is no way to read the Fed’s mandate and not conclude that it is being extremely negligent in failing to take additional actions to assist the economy. The Fed’s only possible defence is that there’s nothing more it can do. I don’t believe this
Krugman’s post makes a similar point:
most important from my point of view, he has seemed deeply worried about defending himself against the inflation hawks, not at all concerned with the question of whether the Fed is doing all it should to fight catastrophically high unemployment.
Given the vast credit operations and low rates, how can Bernanke be accused of doing too little? Here again I must refer people to Sumner‘s blog. Monetary policy is not just about the current interest rate. It is not even just about all interest rates, as anyone following quantitative easing must now realise. It includes everything that financial markets think might happen in the future to do with the price of money and its potential return in the economy. While the Fed appears to have an influence over just one thing – today’s short term risk free rate – financial markets, businessmen and consumers are asking questions about now, the near future, the long future. * Sending out the wrong signals about what you care about far into the future might stymie economic activity today.
If you think this is just academic, consider the following thought experiment. What would happen if, as Baseline Scenario called for, Paul Krugman was called to replace Bernanke? If you think monetary policy is just about the ST rate, then surely nothing much: it can’t go down. But given Krugman’s well-known left-wing views and oft-repeated concern about unemployment, and disdain for inflation hawks, there would surely be a massive response in the financial markets and the economy. Future interest rate markets would drop; so would the dollar. I don’t know about bonds: more growth, more inflation, more QE: these forces can pull apart in odd ways.
In short, surely expectations would take a powerful jolt in the direction of more inflation, and more nominal growth. That is precisely what a liquidity trap needs: it is what they mean when they call for somone committing to being irresponsible. As you-know-who himself observed.
You can change the entire direction of the future path of the economy, just from a change in which bearded Princeton academic is going to chair some meetings. It’s not just about an interest rate.
*as the Economist wrote this week about debt, “borrowing that looks cheap today could double in price tomorrow”. So a current business condition is deeply affected by concerns about a future financial condition.